Unit cost is the cost of manufacturing, storing, selling, and shipping one product. It is the fundamental concept of business and economics and helps company owners make critical decisions about product pricing and profitability. The numerical value of unit cost is essential for strategic planning and decision-making in a business.
In this article, we will discuss the details of what is unit cost, its examples, significance, and more.
What is Unit Cost?
Unit cost in business accounting refers to the total cost associated with manufacturing, storing, selling, and shipping of a product or service. Another term used for unit cost is cost of goods sold (COGS). It can also be known as the average cost or cost per unit sold. Unit cost is the cost of one product or activity. It is essential in business accounting and taxes and determines the operational capacity of the business. It gives an insight into production efficiency to the business owners
Let’s look at cost unit examples:
A company, ABC manufactures and sells women’s shirts. They pay Rs. 15,000 per month for workshop rent and Rs.1000 for electricity bill per month. This means their fixed cost is Rs. 25,000 per month. Additionally, the company is purchasing 2000 meters of cloth at Rs. 30 per meter every month. The total cost of the cloth is Rs. 60,000. The tailor works at a salary of Rs. 15000 per month and stitches 50 shirts. The variable cost of the company for 1 month is 60,000 + 15000 = Rs. 75000.
Now, to calculate the unit cost, ABC company needs to sum up its monthly fixed cost and the variable cost. So, Rs. 25000 + Rs. 75000 = Rs. 100,000. Then, they divide this amount by the number of shirts manufactured per month (50). So, Rs. 100,000/50 = Rs. 2000.
Their unit cost is Rs. 2000, which can be used as a reference to determine the selling price for each shirt. If the company wants profit, they have to sell the shirt at a price above Rs. 2000.
Also read: How to improve efficiency with business accounting software
What is Unit Cost Importance in a Business?
Calculating the unit cost is important for the business as it provides insights into operational efficiency, allowing business owners to take measures to improve processes if necessary. It allows the company to determine the selling cost of the product to make enough profit. The unit costs of the product or service should be lower than the unit cost to make a profit. Many businesses hire a dedicated team working to manage the unit cost of the products. They keep an eye on the unit cost of the products and services and take essential steps to lower unit costs, whenever necessary.
Price setting
Determining the unit cost allows the companies to set competitive prices for products and services. When businesses know the total cost of manufacturing a single product, they can easily avoid underpricing. It helps the companies to make good profits and sell products at reasonable prices.
Efficient resource allocation
Knowing the unit cost of a product helps businesses find out which product is cheap and easy to produce. They can then put efforts into these products which make their work more efficient and save resources.
Decision making
Unit cost helps the business to make smart decisions by evaluating if they need to make changes in the fixed cost or variable cost. Also, they can analyze the feasibility before launching a new product and assess if their decision will be profitable or not.
Performance evaluation
Regularly monitoring the changing costs over time helps the companies to determine whether their cost-saving strategies and process improvement measures are working as expected. It helps the companions to keep making improvements in the operations and adopt cost-saving strategies.
Profit analysis
Unit cost is a vital aspect in analyzing the profit of a company. Comparing the unit cost and the selling price helps in analyzing which product is contributing the most to profit generation. It helps in decision-making and product mixing.
Cost Unit Examples
Here are some real-world cost unit examples to understand the concept of unit cost:
Example 1:
Let’s consider the case of a bulb-producing company which manufactures 10,000 bulbs per month. The company is paying Rs. 20,000 for the workplace rent and Rs. 15,000 for the electricity bill. Also, the raw material per month costs Rs. 8000 and other utility bills cost Rs. 5,000 monthly. Also, the company purchases 10,000 printed packaging materials every month for Rs. 2000. Sum of salaries of workers is Rs. 20,000 per month. So, the total cost incurred in the production process is Rs. 70,000 (Rs. 40,000 as fixed cost and Rs. 30,000 as variable cost)
To find the unit cost of a bulb, they need to divide the total cost by the number of bulbs produced per month. So, Rs.70,000/10,000 = Rs. 7. So, the unit cost is Rs. 7.
Example 2:
Consider another example of the XYZ company producing 20,000 plastic toy cars monthly. The fixed cost of the company is Rs. 55,000 per month and the variable costs are Rs. 35,000 per month. If we have to determine their unit cost, sum up the variable cost and fixed cost and divide by total production per month. So, Rs. 55,000 + Rs. 35000 = Rs. 90,000. Now, Rs. 90,000/20,000 = Rs. 4.5.
The unit cost of the company for manufacturing toy cars is Rs. 4.5. Now they must set the selling price more than Rs. 4.5.
Types of Unit Cost
Understanding unit costing in cost accounting requires knowledge of its types.
There are 4 types of unit cost and each type plays a vital role in the cost evaluation of the products. Let’s have a detailed look at 4 types of unit costs:
Direct Unit cost
Direct unit cost is referred to as the money spent by the company directly for manufacturing a product. For example, If a company is manufacturing mobile phones and purchasing motherboards for mobile phones, the direct unit cost of manufacturing mobile phones will include the cost of one motherboard.
The direct cost of unit production can be calculated by summing up all the direct costs associated with the product and dividing it by the total number of products. For example, in the above case of a mobile manufacturing company, the company is purchasing 100 motherboards at Rs. 5000 and 100 LED lights for torch function in the mobiles for Rs. 1000. The total direct cost will be Rs. 5000+ Rs. 1000 = Rs. 6000. If the mobile phones produced using these items are 100, the direct unit cost will be Rs. 6000/100 = Rs. 60.
Indirect unit cost
The indirect costs of a unit are expenses that are not directly related to the specific product but are the overall expenditures for operational efficiency. For example, A company manufacturing furniture is paying Rs. 120,000 as administrative and facility expenses. The number of products they are manufacturing monthly is 500. So, the indirect cost of a unit will be Rs. 240 Per unit.
Fixed unit cost
Fixed unit cost includes the fixed amount paid by the company and it is not related to the amount of items produced. For example, a company pays rent of Rs. 50,000 per month for a warehouse to store the products. This rent amount is the fixed cost.
To calculate the fixed unit cost, you need to divide the total fixed unit cost paid over a specific duration by the products manufactured during that period.
For example, if a company has a fixed cost of Rs. 100,000 per year and is manufacturing 2000 products in a year, the fixed cost of a unit will be calculated as Rs. 100,000 / 2000 = Rs. 50.
Variable unit cost
Variable unit costs are the expenses that can fluctuate according to the number of products manufactured. For instance, the raw material required for manufacturing the products can be variable if the number of items manufactured increases or decreases.
To calculate the variable unit cost, you have to sum up all the variable expenses for a specific duration and then divide it by the number of product manufacturers in that duration. Let’s understand it with an example, Suppose, A wood furniture manufacturing company produces 50 sofas per month and the raw material used in them costs Rs. 15,000. So, the variable unit cost will be Rs. 15,000/50 = Rs.300
Also read: Everything you need to know about cost accounting
What is the Unit Cost Calculation Formula?
Here is the formula for calculating the unit cost:
Unit cost = Total cost ➗ Total number of units produced
Here, “Total cost” includes the sum of all direct costs such as raw materials, workers, and other overhead expenses.
“Total number of units produced” includes the quantity of the items manufactured in the company in specific duration. “
Let’s understand this formula using cost unit examples:
Suppose a manufacturing company purchases the raw material of Rs. 15000 to produce 1000 units in a month. Overhead expenses for the month are Rs. 5,000. Total direct expenses will be Rs. 20,000. Applying the formula to this case:
Unit cost = Rs. 20,000 / 1000 units = Rs. 20 per unit.
Tips to Calculate and Analyse the Unit Cost
Calculating and analyzing the unit cost helps the business to estimate the cost efficiency of producing items. Here are some tips that can help you calculate and analyze the unit cost easily:
Collect the cost data
Firstly, all the cost data related to production or the items or procurement of the services, such as salaries of the workers, all indirect expenses, and other costs associated with administration, must be collected.
Identify the unit cost type
Identify what is unit cost type that you wish to calculate such as direct, indirect, fixed, or variable. It will help you carry on the calculations and conduct analysis.
Determine total cost
Add all the expenses of production or procurement for a specific period. This total cost will include all the cost data collected in Step 1.
Determine unit cost
Count the total number of items produced in the company over that specific period.
Apply formula
Use the formula for calculating unit cost (Unit cost = Total cost ➗ Total number of units produced)
Interpret results
Once you have the results, do the interpretation. Compare the current results with the previous data and analyze the cost efficiency. Identify if there are fluctuations and if the cost of the unit is aligning with the pricing strategies. Check for the gross profit margin.
Identify areas for improvement
The calculation of unit cost will help you find out where you need to make changes and improvements in your strategies. Also, you can adopt the ways for cost saving and getting good profit.
Factors Affecting the Unit Cost
There are many factors which affect the unit cost:
Economies of scale
When the number of products manufactured during a specific time is higher, the unit cost reduces. This happens in the case of fixed costs (such as machines) that can be used to manufacture more products. Similarly, buying material in bulk reduces the unit cost in the B2B model.
Volume of production and capacity utilization
If the production volume is higher, the unit cost will be lower because of spreading fixed costs. Moreover, Using the resources fully and not wasting time can further help in reducing the unit cost.
Input prices and supplier relationships
Higher prices of raw materials will lead to an increase in unit cost. So, a good relationship with suppliers can help you secure good deals and discounts to reduce the unit cost.
Efficiency and technology
The use of updated technology in production units and efficient processes can lead to saving time and money. It also reduces the required number of workers and production becomes even faster. Adopting new technologies can save more cost.
Learn how you can optimize costs with customized reporting solutions
What is a Cost Sheet?
A cost sheet is a financial document of a company that provides complete details of all the incurred costs over a specific period. It is usually related to the production of goods and services. A cost sheet helps business owners to track and manage expenses and make informed decisions for the betterment of the business.
Importance of Cost Sheet
The cost sheet is essential for various aspects of the company. Let’s have a look at the importance of cost sheet in business:
- Cost determining: A cost sheet is used to obtain the accurate cost of the product. It provides detailed information about the total cost and the unit cost of a product.
- Setting selling price: creating a cost sheet allows the business owners to fix the selling price of a specific product. It helps in getting enough margin while staying in the competitive market.
- Cost comparison: The cost sheet helps the managers to compare the current cost of a product with the previous cost. Comparing the costs allows the business owners to take essential steps in reducing the costs.
- Cost control: cost sheets help to control the production cost of the items. It also allows monitoring of labor, raw material, and overhead costs included in the production.
- Decision making: Cost sheets are the basis of the decision that management makes regarding the cost of the product. When a company buys a component or sets the price of a product, the managers consider the cost sheet.
Also read: What and how of managerial accounting
Bottom Line
Every decision made and every policy adopted by the managing team can have a great impact on the financial conditions of the company. A detailed analysis of unit cost helps to guide the decision-making journey. Right from setting prices while staying competitive yet affordable to optimizing resource allocation, unit cost can help in managing everything efficiently.
The accuracy of unit cost is essential for mastering financial decisions. Keep in mind that unit cost is more than just numbers, it is the key to making informed decisions and maximizing the profit.
FAQs
What is unit costing in the cost accounting of a product or a service?
The unit cost of a product is the total expense incurred to produce a single unit or provide a service. Businesses calculate the unit cost of a product to ensure they are not underpricing and making enough profit.
What is the process to calculate the unit cost?
Calculation of unit cost can be done using a simple formula: Unit cost = Total fixed cost/ Number of products. Here, you can use other expenses such as variable costs, direct costs, or indirect costs to calculate the unit cost.
What is the difference between unit cost and net price?
The net price of the product is the list price minus the trade discount. While the unit cost is the expenses incurred for manufacturing the product.
What is a unit cost example?
Unit cost is the amount spent for manufacturing a single piece in a company. For example, if a company is manufacturing wristwatches, the fixed cost is Rs. 15000 over a specific period and the variable expenses are Rs. 5000 in that period, and the number of wristwatches produced in that duration is 200. So, the unit cost will be Rs. 100.
What is the need for unit costing?
Unit costing is an essential aspect for analyzing the profitability of the business and setting the selling price of the product. It provides a quick insight to the company owners if the production is efficient or not. Also, unit costing helps companies to make informed decisions and make strategies for enhancing efficiency.
What is the objective of unit costing?
The objectives of unit costing are: 1) to determine the total cost of producing the product and the cost of producing a single unit of that product. 2) To determine the profit and loss associated with the product. 3) group the cost into different categories and determine how much each category contributes to the total cost.
Which factors influence the Unit cost?
The factors affecting the unit cost are Type of product, Product complexity, Scale of production, Production location, Raw material cost, labor wages, and other overhead expenses.
What is the formula used for calculating the unit cost?
The formula used for calculating the unit cost of a product is Unit cost = variable cost+fixed cost/ number of units produced.
Explain the cost unit and cost centre.
A cost center is a department of the company that is responsible for tracking and measuring costs. A cost unit is the cost of producing one unit of a product.
What is the synonym used for cost sheet?
The cost sheet has the details of all the cost data to help businesses make informed decisions and control costs. The other terms used for the cost sheet are “Statement of cost” and “profit or cost statement”.
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